March 5, 2024

In a sign of growing instability, loans to US shadow banks pass $1 trillion

Federal Reserve Building on Constitution Avenue in Washington [AP Photo/J. Scott Applewhite, file]

The US Federal Reserve has revealed that a significant financial milestone was passed last week. The amount of money lent by US banks to so-called shadow banks, otherwise known as non-bank financial institutions (NBFIs), has passed the $1 trillion mark.

As significant as the amount is, equally important is the speed with which it has occurred.

As the Financial Times (FT) reported, the lending is “up 12 percent in the past year, making it one of banking’s fastest-growing businesses when overall loans growth has been sluggish, up just 2 percent.”

The rapid rise in lending by banks to shadow banks is causing concern among financial regulators. Numerous reports, including from the International Monetary Fund, as well as statements from the regulators themselves, have made clear very little is known of the connections between them.

The FT reported that Michael Hsu, a top regulator at the US Office of the Comptroller of the Currency, had noted in a recent interview that the lightly regulated lenders, the shadow banks, were pushing the banks into lower-quality and higher-risk loans.

“We need to solve the race to the bottom,” he said. “And I think part of the way to solve it is to put due attention on those non-banks.”

The acceleration is indicated by the fact that when banks were first required to reveal their lending to non-banks in 2010 the total was just $50 billion for the entire banking sector. It is now 20 times that level and comprises 6 percent of all loans. This is more than auto loans, at 5 percent and just under credit card loans at 7 percent.

Across the Atlantic, European Union regulators are also seeking to probe the connections between the banks and NBFIs about which they confess to know very little. The worry is that if operations by a shadow bank go sour it can pass into the broader banking and financial system.

The potential damage was seen most notably in the crisis of the US Treasury market in March 2020 when a “dash for cash” was sparked, at least in part, by the activities of hedge funds. The freeze in the market, which went on for days, meant there were virtually no buyers for US government debt. It was only ended, and a major financial crisis averted, through a massive intervention by the Fed to the tune of $4 trillion.

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